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TCC’s regulatory update for the end of May

Regulatory team, TCC, London, 31 May 2017

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May has been a relatively quiet month in relation to April, which saw the UK’s Financial Conduct Authority reveal its business plan for 2017/18, but the regulator has now finally published its consolidated findings regarding suitability.

A number of other themes feature highly on the regulator’s agenda and firms should keep them in mind as they venture into the second half of the year.

Assessing Suitability

The FCA has published the findings from its long-anticipated ‘Assessing Suitability’ work, which saw the regulator review 1,142 pieces of advice given by 656 firms from all over the financial services industry in an effort to see whether they complied with its suitability and disclosure rules. Disclosure rules include COBS 6.4 on the disclosure of charges, remuneration and commission to clients.

The regulator found that in 93.1% of cases, the sector provides suitable advice, but the results regarding disclosure were less positive, with only 52.9% of files the FCA reviewed showing that appropriate disclosure had taken place. Although the 93.1% figure is likely to grab all of the headlines, firms should not draw any false reassurances from this figure as it only indicates whether clients ended up with a suitable result, not whether firms had been able to prove that their recommendations were suitable.

In the report the FCA specifically highlighted failings to do with initial disclosure and the quality of suitability reports, raising concerns that they were too long or overly complex, but these issues would not have affected the overall suitability figure. The regulator did, however, note that these were persistent issues, previously identified during its thematic work on the efficacy of the Retail Distribution Review in 2014. Rest assured that suitability will continue to hold the FCA attention as it arguably represents the largest source of risk inherent in the sector.

The rest of the paper outlines the findings of the review in outline, split into type of advice, type of firm, advice area etc. Two key areas the FCA when considering suitability were risk profiling and replacement business, where it uncovered weak processes. Specifically, it found that firms were recommending replacement business without clear, written reasoning and were failing to take into account the limitations of any risk profiling tools they were using. Firms would be wise to consider the published guidance in each area and review their own processes to identify and mitigate any risks or weaknesses that may be present.

The long wait for firms for the results is far from over. Rather than publish a singular comprehensive report, the FCA plans to drip-feed its pronouncements about the ‘good’ and ‘poor’ practice it identified during this review over the coming months and in a variety of media. This will form part of a wider communications strategy which will extend into 2018. Although this will keep suitability in the public eye for the immediate future, it does mean that we are going to miss out on the benefits of a consolidated “good and poor practice” document, or a consultation about new guidelines, an approach previously adopted by the regulator.

As indicated in its Business Plan, the FCA has confirmed that it will formally re-run this exercise in 2019, using advice given in 2018 after PRIIPS, MiFID II and the IDD have come into force. The regulator will “conduct specific work” to target firms providing unsuitable advice on complex products, another area of concern highlighted in its Business Plan.

Crucially, the report concludes that, due to the relatively small differences in its findings, the FCA will not materially alter its supervisory approach in accordance with the results of the ‘Assessing Suitability’ review.

The regulator’s perspective on competition and innovation

The FCA’s executive director of strategy and competition, Christopher Woolard, delivered a speech outlining the its desire to promote innovation and competition in the financial services market, and also its approach to its regulatory duties.

Competition and innovation strategy

For financial markets to function effectively, so the FCA’s reasoning goes, they must promote competition that makes firms innovate on behalf of customers and give them value for money. Innovation has influenced the development of new technologies and has revolutionised the accessibility of products and services for consumers. However, if innovation or competition pose a risk to consumers or the market, the FCA has a duty to intervene.

Regulation is a persuasive shaper of markets and the FCA intervenes in them with the aim of making consumers confident enough to explore the markets and make appropriate choices. This has a disciplining effect on firms, encouraging them to develop products and services that meet consumers’ needs and expectations about quality and price. The FCA also works closely with the Prudential Regulation Authority (PRA) in this area, having opened the New Bank Start-Up Unit in early 2016 to support new banks and projects to start banks up.

Duty of ensuring that competition takes place

Not only is the FCA obliged to regulate firms effectively, its remit also includes the use of its competition powers to ‘mediate’ the market. The regulator is expected to publish a statement about its approach to competition, outlining the way competition affects its work. This stems from the issue of weak price competition identified in the FCA’s Asset Management Market Study. Findings showed that the volume of charges was affecting the value of the average consumer’s long term investments and pensions. The FCA therefore aims to try to make consumers ‘clear’ about price, objectives and performance so that they are better placed to obtain the most from the market.

Promoting innovation

The FCA looks on new entrants and innovations in the market as a way of forcing firms to compete with each other for the benefit of consumers. Innovation in the financial services industry entails the constant improvement of products and services which, hopefully, meet consumers’ needs. To support this, the FCA introduced Project Innovate in 2014 to help firms overcome regulatory barriers, either by making its expectations clear, by reviewing its rules or by changing its policies.

Progressive and protective approaches

The main purpose of the FCA’s focus on innovation is to improve the everyday lives of consumers and equip firms with the knowledge they need when they enter the market.

FCA signs further RegTech co-operation agreement

The FCA has signed a co-operation agreement with the Hong Kong Securities and Futures Commission (SFC) to support ‘FinTech’ in both regulators’ markets. This follows similar agreements between the FCA and regulators in Japan and Canada.

Both authorities have promised to share relevant information and help innovative FinTech firms move from one market to the other, offering more support than they do already to businesses that are thinking of expanding internationally.

On the horizon: broader trends in FCA supervision

The future is the source of much uncertainty, with the UK’s General Election and ‘Brexit’ negotiations imminent. These pressing issues aside, the future shape of the financial services industry is also uncertain, with emerging technology, evolving demands from customers and shifting regulatory priorities sure to change the way the industry operates.

New laws and regulations

For the year ahead, the FCA is concentrating on the compliance of firms with several new laws that are emerging from the European Union, including MiFID II.  

Every firm ought to prepare for the new regulations well, with a comprehensive ‘transformation plan’ in place to help it meet the deadlines.

The regulator will also try to find out how well firms are preparing to manage the risks associated with the technologies and systems they use, including the risk of cyber-attacks and systems going down. Complex outsourcing arrangements can make it harder for firms to oversee their operations and can allow risks to go undetected.

The need for robust governance and the right culture

Poor governance and culture are often at the heart of many failings at firms and can lead to bad results if those firms do not change them; indeed, they can make business less sustainable. The FCA has made its expectations clear in this area: firms must have an appropriate, customer-centric culture in place, supported by a robust business model, strategy and governance arrangements that are aligned to appropriate conduct.

The FCA will continue to monitor the causes of poor culture and the rate of change across the industry, while also working towards its plans to introduce its ‘accountability’ regime to all the firms it regulates in 2018. As a result, firms cannot afford to ignore the issue and should try to gain a thorough understanding of internal culture and whether their culture is aligned with the FCA’s expectations.

Tackling weak competition

The FCA highlighted competition as one of its cross-sectoral priorities in its 2017/18 business plan. The Asset Management Market Study was really the industry’s first taste of the FCA’s approach to  the issues that arise from weak competition in financial services.

The FCA’s approach concentrates on identifying and addressing things that can act as barriers to the virtuous “circle of competition.” Ultimately, it believes, competition prompts firms to meet consumers’ needs and consumers can cause firms to compete more fiercely with one another when they are better informed and more deeply involved in finance. Any market is open to the prospect of investigation and intervention because of the FCA’s remit to promote competition.

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